Debt settlement is rarely a done deal

When I’m asked, “What do you think of debt settlement?,” I cringe. I gird myself for a frustrating discussion with desperate debtors looking for a quick fix to a problem they’ve spent years creating.

They want to get rid of their debts as easily as baking a potato in the microwave. They want the phone calls to stop. They want the letters to stop. They need to get rid of the stress they are experiencing.

And so they want to believe — need to trust — the advertising from debt-settlement companies that claim a significant reduction of debt for just pennies on the dollar. An online ad for one firm promises that “if you owe $30,000, you could resolve your debt in as little as 24 to 48 months.” The statement comes with a fine-print caveat saying that, including fees, clients still end up paying as much as 75 percent of what they owe. And there is no guarantee the program will work.

There you have it. Nuking the majority of your debt away in short order is just a pipe dream for most people.

Only about one in 10 consumers participating in debt-settlement programs actually ends up debt-free in the promised period of time, according to a consumer alert issued recently by the nonprofit National Association of Consumer Bankruptcy Attorneys.

Debt-settlement companies promise to act on your behalf to negotiate with your creditors to reduce your debts. Typically, customers are told to stop paying their bills and instead send money to the debt-relief firm, which holds on to the money with the intention of offering creditors a lump-sum offer for less than what’s owed.

“Bombarded with slick radio and Web advertising falsely promising a smooth road to being debt-free in a short period of time, these companies prey on the most desperate victims of the economic downturn,” said Ed Boltz, a North Carolina bankruptcy lawyer and incoming president of the consumer bankruptcy association. “These particularly vulnerable consumers usually end up getting sued, stuck with outrageous fees, more deeply in debt, and far worse off in terms of their credit score.”

One of the biggest problems with debt-settlement programs is that they encourage consumers to default on their debts, Boltz said.

Let’s look at two cases of failed debt-settlement plans, provided by the association.

The people: A Florida couple with about $60,000 in credit card debt and a California retiree with $79,000 in bills.

The program: The debt-settlement company told the Florida couple that they needed to pay $31,200, including the firm’s fees, to free themselves from their debt — a savings of $28,800. The firm took an upfront fee of $6,900 and started collecting monthly payments of first $460 and then $230. The couple couldn’t afford to keep up the payments and never got any debt settlement.

A 77-year-old Californian said he was watching television and saw a commercial for a debt-settlement company claiming it could reduce his debt by 50 percent. The company began taking $1,800 a month out of his bank account. “As I started reading the contract, I realized I would have to pay 15 percent of the gross [debt] amount or close to $12,000 upfront out of the $1,800 before settling any debt,” the retiree said during a teleconference.

He ended up paying the company $25,200. Not one of his debts was settled.

Federal rules put in place two years ago aimed at reining in bad players in the industry now make it illegal for debt-relief services to charge upfront fees. Companies that sell their services over the telephone can’t get paid until they successfully settle or reduce a customer’s credit card or other unsecured debt. The companies have to make specific disclosures to potential customers — how long it will take to get results, how much the service will cost and the potential negative consequences that could result from seeking debt relief. The firms are also prohibited from misrepresenting what they can do for debtors, in particular the percentage of debt that is typically erased.

The Federal Trade Commission recently charged an Ohio company and its owner with fraudulently claiming on 17 Web sites that consumers could quickly get out of debt if they used several debt-settlement companies to which they referred people. The company’s owner agreed to a $390,000 settlement.

If you’re thinking about debt settlement, go to www.ftc.gov and search for “Debt Relief Services.” Read the advisory by the consumer bankruptcy association at www.nacba.org.

The consumer alert may seem self-serving coming from bankruptcy attorneys, but the message is nonetheless important. A quick fix to get out of debt could end up causing you more financial pain and stress.

Readers can write to Michelle Singletary at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071, or singletarym@washpost.com. Personal responses may not be possible, and comments or questions may be used in a future column, with the writer’s name, unless otherwise requested. To read previous Color of Money columns, go to postbusiness.com.